Taxing Chinese Goods Due to Currency Manipulation: Wrong Solution, Wrong Problem

China. Tariffs. Trade war. Oh my.

Last week, the Senate passed the Currency Exchange Rate Oversight Reform Act (S.1619) and is on the Presidents desk, waiting for an answer. The act is set to tax exports from any country that undervalues its currency in order to gain an advantage in trade. I think we all know what country was in mind when this was written. China.

China has been undervaluing their currency by more than 20%

No doubt China has been undervaluing their currency. Some say as much as 28% and that’s a hefty percentage. The lower the value of the Yuan, the more Asian-persuasion President Hu Jintao has to keep money flowing into China’s economy. Certainly it’s frustrating to U.S and to our government. But the bill the Senate has passed isn’t the solution to the problem.

The Currency Exchange Rate Oversight Reform Act bill intends taxing Chinese exports to the United States, also known as tariffs. Theoretically, tariffs are designed to tax imports from foreign countries, making foreign goods more expensive to buy. It’s often designed to protect domestic jobs, protect small industries, or shield national defense. If Wal-Mart produces a toy in China because it costs $2 to build rather than $4 in the U.S, then China will be the home of many Wal-Mart factories. But if that same toy that is imported to the United States is taxed $3, bringing it total cost of $5 for that toy, then Wal-Mart and China’s economy will suffer because U.S consumers would rather buy $4 toys made in the U.S. Sounds ideal, but like most government laws, reality is far from D.C hypotheses. In reality, most governments retaliate with tariffs of their own, sparking a trade war between countries. Costs rise as well as unemployment. Nothing good comes from tariffs.  We’ve attempted tariffs before. Countless times. And they’ve failed.

In 1928, Washington D.C proposed enacting the Smoot-Hawley Tariff Act. The law would tax more than 20,000 imports, making it the second largest level of tariffs in U.S history. President Hoover and his staff were warned, just like China is warning us now. 1,000 economists sent a plea letter to the President asking him not to pass the law. There was also pressure coming from traders, threatening retaliation. In 1929, the stock market crashed and President Hoover ignored the pleas and passed the bill in 1930. The Smoot Hawley Tariffs sent the economy into a tailspin. Outside countries retaliated, raising tariffs on U.S exports and U.S unemployment went from 6.3% to 11.6% within six months.

Placing tariffs on China will be no different than the tariffs in the past. Our current administration found that out in 2009, when tariffs were placed on Chinese tires. China retaliated and placed tariffs on American auto parts. Were jobs gained? No. Did prices on consumer goods rise? You betcha.

There’s no doubt that China’s economy is growing. The U.S-China trade deficit increased 7.4% for the month of August, setting it at a new high of $29 billion for the month. That’s no good, considering we already have a staggering $189 billion trade deficit this year. At this rate, the U.S-China deficit of 2011 is set to surpass last year’s deficit of $273 billion by almost $20 billion. That’s scary. What’s even scarier is that the IMF has predicted that China’s economy will overtake the U.S economy by 2016. 

Let’s take a step back though and assess the situation. Let’s say we do place tariffs on China’s exports and a trade war starts. What happens to the Chinese based companies that are selling their items for dirt-cheap? Do the jobs come back to the U.S? I wish, but no – they won’t. They’ll go on to the next cheapest country where the cost is just as cheap as China. In 2005, America placed a tariff on Chinese furniture. Instead of moving jobs to the U.S as our government wanted, the companies moved their operations to bordering countries like Vietnam. The cost of making furniture in other countries was still cheaper than U.S costs. So China’s currency isn’t the real problem is it?

As long as costs are cheaper in other countries, the United States will continually fail to bring jobs back home. The real problem is not China; it’s the cost of doing business in the states. 81,000 pages of regulations. Class warfare. A government overhaul on healthcare. Restricting businesses from building factories in certain locations, because the state is not a union state. Pick your poison. These aren’t conservative talking points; they’re facts. And unless Washington gets serious about the facts, we will continue to be in a huge trade deficit with China and other foreign countries.

Currency manipulation isn’t the real problem. Government economic policies are.